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Negative Real Interest Rates & Endowment Investing 负利率对捐赠基金开销政策的影响

In the U.S., the real (i.e. inflation-adjusted) rate of return on almost all federal government bonds is negative; such downward trend in government yields is not a recent phenomenon. In fact, negative real interest rates existed in the 1930s, 1940s, 1970s, early 2000s, and today. Over the last 15 years, the U.S. 5-year real interest rates have declined from 4% to -1.3% a year.

U.S. Nominal and Real Yields as of July 3rd, 2012 (In Percent Per Annum)

*Source: Board of Governors of the Federal Reserve System

The Increase in the Supply of Money Has Driven Interest Rates Down

Why real yields are so low? If you followed Fed’s policies and Bernanke’s speeches, you would probably have got the same sense as I did: a combination of forces had caused a significant increase in the global supply of savings:

  1. Deterioration in the U.S. current account, namely, trade deficit
  2. Growth in the emerging markets
  3. An upward trend in oil prices
  4. Dramatic increase in the foreign currency reserves, a measure of savings at the sovereign level:

In addition, China’s demand for U.S. Treasuries has gone from $60 billion to more than $1.1 trillion

All the evidence has indicated that there has been an enormous increase in the supply of money flooding into the U.S., which has driven the interest rates down.

What does a negative real yield mean?

A negative real yield implies that 1) it is much cheaper for the U.S. government to finance some undertaking by borrowing the money and paying for it out of taxes years from now than to pay with taxes; 2) investors are willing to see safe investments decline in purchasing power; 3) a positive real return can be achieved only by taking significant risk.

Negative Real Rates & Endowments Spending Policies

The negative-real-yield environment presents challenges for assets selection and strategic asset allocation for endowments and foundations. Endowments generally targeted “CPI plus” or “HEPI (Higher Education Price Index) plus” as long-term return objective. According to NACUBO study, in 2011, the average annual effective spending rate for educational endowments was 4.6 percent, which means that endowments need to earn 4.6 percent after inflation to maintain current spending levels. There are a couple of choices of spending policies in coping with the low-real–interest-rate environment, but please keep in mind that investing is all about the tradeoffs between risk bearing and return maximization:

1) Maintain stability across changing risk environments, e.g. a traditional balanced portfolio (60/40) and the current spending level:

2) Maintain a traditional portfolio but reduce current spending and/or additional resources to maintain future purchasing power

3) Increase exposures to risky assets, however, endowments may have to accept the maximum drawdowns:

4) Active management, to seek managers who are able to outperform through security selection, exploitation of market inefficiencies, and astute market timing

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